Cactus: Interesting Start To 2023 (NYSE:WHD)

In February 2018, I wondered if shares of Cactus, Inc. (NYSE:WHD) represented a promising IPO, or whether a sting could be expected. Its wellheads and related products were in great demand, as the company essentially operated an oligopoly with some other service providers, leaving me questioning on the sustainability of these margins.

A Recap

Cactus is a designer, manufacturer and marketer of wellheads and pressure control equipment, being sold and rented out to exploration companies of unconventional oil and gas wells, during the drilling, completion and production phase of these wells.

The Cactus SafeDrill wellhead system stands at the forefront of the offerings, complemented by other products as well as maintenance and emergency assistance services. Many of these products were internally developed, supported by internal engineering expertise and customer feedback, with the company´s products being used in about a quarter of the U.S. onshore rigs.

The company sold 21 million shares in 2018 at $19 per share, raising $407 million in gross proceeds in the process. With 75 million shares outstanding, the company was valued at $1.42 billion, that is the equity, as a pro forma net debt load was very minimal.

The company generated $221 million in revenues on which an impressive $42 million profit was posted in the year 2015. Revenues fell 30% to $155 million in 2016, while operating earnings fell to $10 million, albeit that many peers were posting losses at the same time. The company grew sales in a spectacular fashion, with revenues up 125% in the first nine months of 2017. Revenues were reported at $236 million for this period of time, as operating profits rose in a spectacular fashion to $60 million.

With fourth quarter revenues projected at $105 million and earnings coming in a lot better, Cactus, Inc. was on track to generate $400 million in revenues and around a hundred million in operating earnings. Based on that, I pegged earnings power at around $1.20 per share, as the 17-18 times multiple for an unleveraged business with apparently sound fundamentals looked quite compelling, even as the company was trading against the likes of Schlumberger (SLB), General Electric (GE) and Technip.

While the valuation was quite compelling, and it was quite clear that the company was doing something very good, I wondered how long the momentum could last, hence how sustainable the momentum was. Furthermore, the conventional energy industry has long term concerns of course given the rise of the ESG practices and move to sustainable energy, even as this is a multi-decade transition of course.

What Happened?

Fast forwarding between 2018, and today I must admit that I should have listened to my gut feeling, as Cactus, Inc. appears to be of high quality and seems to have a strong competitive position. Shares ended doubling to $40 in October 2018, marking very strong returns in a rather short period of time. Shares fell to just $10 in the spring of 2020 amidst the pandemic breaking out as shares rallied to the $60 mark in spring of 2022, with the world fearing a global energy crisis following the Russian – Ukraine war. Following a dip to the $35 mark this past summer, Cactus, Inc. shares now trade at $50 today.

In February 2022, the company posted its 2021 results, which showed a meaningful recovery from 2020, for obvious reasons. Revenues rose by about a quarter to $438 million, making modest gains from the pro forma revenue base of around $400 million back in 2018. Operating earnings rose in a modest fashion to $75 million as earnings power of $0.72 per share comes in meaningfully lower than seen at the time of the IPO.

These earnings fell short compared to the 2018 situation, but shares held up well, with shares starting the year around the $40 mark. The company ended the year with some $300 million in net cash, equal to about $4 per share as the company has been retaining the earnings over the past couple of years.

It should be said that higher prices already drove results, with fourth quarter revenues trending in excess of half a billion, with earnings trending around a dollar per share. Momentum continued in the first quarter of the year, with revenues rising further to $146 million, with adjusted earnings improving to $0.30 per share.

Second quarter sales rose even further to $170 million, with earnings advancing further to $0.44 per share. In November, third quarter results revealed a quarterly revenue number of $184 million and earnings of $0.52 per share. Obviously, these are very good conditions for the firm to operate within, at this rate the company is generating about $700 million in revenues on which it is set to earn $2 per share. The net cash position has risen to $320 million in the meantime, equal to $4 per share.

With 75 million shares trading around the $50 mark, the company commands a $3.75 billion equity valuation, a number which falls toward $3.4 billion if we factor in net debt. These are still somewhat demanding valuations at around 5 times sales and about 23 times earnings, in generally strong times for the business.

A Deal

While the news has been rather quiet on the corporate front since the public offering, Cactus has started 2023 with a substantial deal. The company has reached a $621 million deal to acquire Flexsteel, a manufacturer of differentiated onshore spoolable pipe technologies.

If revenue targets for 2024 are met, the deal tag could rise by $75 million as the revenue multiple of the activities looks rather modest. With $265 million in revenues reported in the first nine months, a $350 million revenue contribution looks within reach, indicating that the deal takes place at around 2 times sales.

The current net cash position of $320 million will turn into a pro forma net debt load of $300 million, a reasonable number given the profitability of the core business and the acquired activities. With a 6 times transaction multiple, the deal should contribute more than a hundred million in EBITDA, which looks like a low multiple.

The lower multiple looks quite compelling as the exposure to (other) industries (construction, even agriculture) looks compelling as well I must say, as the company seems to have found a good use for its strong net cash position.

Final Takeaway

With the core operations trading at an unleveraged basis at 22-23 times earnings, the deal looks quite compelling. While hardly a share price reaction was seen, I think Cactus, Inc. could grow sales and earnings by nearly 50%, and earnings a bit less given the incurred interest expenses and forfeited interest income, yet a >$2.50 per share number with modes leverage should be easily attainable, with a real runway for earnings to rise to $3 per share.

Amidst all of this I am gradually becoming more upbeat on Cactus, Inc., not yet willing to commit capital, but certainly will be keeping an eye on the business after a nearly transformative deal.